Washington, D.C., 24 April 2004Global Economic Prospects
According to the latest forecast of the United Nations Department of Economic and Social Affairs, gross world product (measured at market exchange rates) will grow by 3.7 per cent in 2004. The accelerating phase of the expansion in most economies is, however, expected to end gradually in the second half of 2004, with the growth of GWP moderating to 3.4 per cent in 2005. The key challenge for policymakers worldwide at present is to achieve, to the maximum extent possible, more balanced global growth and, at the same time, to control the downside risks so as to avoid a reversal.
An encouraging aspect of the recovery is that it is widespread, although there are conspicuous differences in economic vigor across regions and individual countries. On the positive side, the rebound encompasses some newly emerging engines of economic growth. China continues to expand apace, acting as a driving force not only for the Asia region but also for several other economies; in addition, China is now an important player in several international markets, particularly for raw materials and oil, and has an impact on prospects for many other economies through these markets. India is also beginning to play a similar, but more limited role, while the Russian Federation has become an important catalyst for the members of the Commonwealth of Independent States and neighboring countries. Meanwhile, the apparent recovery of the Japanese economy has finally restored an important dimension of global growth. This overall broadening of growth is not only beneficial in its own right but also reduces the risks associated with the former heavy dependence on the United States as the sole engine of global growth.
Less encouragingly, economic activity in most Western European economies has been largely anemic. More importantly, growth in many developing countries, while improving, remains inadequate. Growth in 2004 is forecast to be around 3½ per cent in Latin America and some 4 per cent in Africa and only about half a percentage point higher the following year. Such modest growth is well below what is widely viewed as necessary to achieve the Millennium Development Goals in these continents, most notably, given their increasing populations, to make any meaningful impact on poverty. This is particularly so because the recovery has not yet resulted in any large-scale increase in employment. In the United States, this has given rise to the term “jobless recovery”, but the phrase is equally applicable to most developing counties where the need for jobs is most acute. Further improvements in the global economic environment, including international economic policy, as well as additional domestic reforms, remain crucial if the lagging developing countries are to attain the higher sustainable rates of growth necessary to achieve meaningful development progress.
Despite the improvement in the global outlook, there continue to be major downside risks for the world economy. First and foremost, the emergence of a large fiscal deficit to accompany the external deficit of the United States has increased the uncertainties relating to the global imbalances and the associated prospects of damaging volatility, or a sudden correction, in international financial markets. In addition to exchange rate adjustments, market-driven increases in long-term interest rates from their recent historical lows seem likely to accompany policy-driven increases in short-term rates. On top of the direct effect that these developments will have on economic growth, there are heightened financial vulnerabilities due to higher levels of private and public sector debt in a large of number of economies, as the IMF has highlighted. Finally, political instability and geopolitical concerns have become almost endemic and so remain important sources of uncertainty for the global economy as whole, with particularly adverse consequences for the economic prospects of a number of economies, notably in Western Asia.
Crisis Prevention and IMF Surveillance
Developing countries, supported by the international financial institutions, have taken a wide range of measures over recent years to prevent financial crises: macroeconomic policies have improved and become more transparent, with reduced fiscal deficits and lower rates of inflation; a wide range of structural and institutional reforms have been adopted; external debt situations and their management have improved; financial standards and codes have been implemented and financial monitoring strengthened; and foreign exchange reserves have been increased.
Despite the improved global economic situation and outlook and the improvement in their domestic economic management, developing countries and economies in transition remain highly vulnerable to the global uncertainties and risks referred to above. The increases in interest rates that are anticipated as the recovery strengthens will have direct adverse consequences for developing countries that are active in international capital markets. More importantly, however, the global imbalances could have far-reaching repercussions in international financial markets, notably continued volatility in exchange rates and additional upward pressure on international interest rates. Changes in the exchange rates among the major currencies will have different net effects on individual developing countries and economies in transition, with some receiving a net benefit and others a net loss, depending on country circumstances and the time period under consideration. However, most of these countries are less well equipped than developed countries to manage volatility in exchange rates and some are likely to suffer a negative short-term shock. Similarly, additional upward pressure on long-term international interest rates can only have a negative impact on individual developing countries and economies in transition since the overwhelming majority of these countries are net borrowers.
The recent rise in commodity prices is a welcome respite for commodity-exporting developing countries and is contributing to the acceleration in growth in many of the world’s poorest nations. However, the speed and magnitude of the increase in some prices present some countries with the challenge of managing an unanticipated boom. Moreover, the higher prices may prove to be unsustainable and commodity-exporting countries may be faced with an equally sudden, but far more damaging, reversal. In order to mount a sustained development effort, the poorest countries need not only higher but also less erratic growth. The current rebound in many commodity prices does not detract from the underlying difficulties created for many developing countries by their excessive dependence on such commodities and the long-term downward trend in their prices.
In addition to the actions taken by developing countries and economies in transition themselves to weather such shocks, the international community needs to make maximum use of all existing arrangements and to apply both its ingenuity and its resolve to devise and adopt additional policies and measures to reduce these countries’ vulnerability to developments not of their making. The Contingent Credit Line was an effort in this direction, and it is important that a similar but operative mechanism be designed. The reform of the Compensatory Financing Facility is also crucial in this regard. The World Bank’s “deferred drawdown option” (DDO) is another effort to protect against the effects of reduced access to international financial markets and it is encouraging that several countries have already arranged DDO facilities.
It is essential to continue the quest for measures to assist in preventing crises and in resolving them when they occur. Some possibilities have been under discussion for some time and do not seem to pose major technical difficulties. One such measure would be to adopt the special one-time allocation of SDRs endorsed by the IMF Board of Governors in 1997. An extension of this would be to resume periodic allocations of SDRs in order to reduce the need for developing countries and economies in transition to accumulate, at considerable cost, foreign exchange reserves. It has also been suggested that, in such context, developed countries would make their allocations of SDRs available for development purposes. Another proposal has been to make counter-cyclical allocations of SDRs, to facilitate emergency financing during crises and avoid at the same time creating additional world liquidity in the long term.
Developing countries can have very little influence on these developments in the international economy and yet are subject to them. It is the responsibility of the developed economies, particularly the largest among them, to take measures to ensure global economic stability. At present, this requires collective action to ensure an orderly unwinding of the global imbalances, suggesting that multilateral surveillance for the time being should focus primarily on the policies of the largest economies. It is particularly important to ensure that the adjustment process does not disrupt the development efforts of the poorest countries. It will therefore be necessary to ensure not only a consistent approach across countries but also coherence between policies and measures intended to restore macroeconomic balance in the world economy and those intended to foster long-term growth and development in the developing countries. Above all, there should be no relaxation in the commitments to advance development made by the developed countries in the United Nations Millennium Declaration, the Monterrey Consensus, the Doha Development Agenda and the Johannesburg Programme of Implementation.
Promoting Debt Sustainability
As it was pointed out, changes in exchange rates and international interest rates are likely to take place in the foreseeable future. In the past, such changes have been the source of disproportionately large changes in developing countries’ debt burdens and a cause of severe external debt difficulties for some individual countries. Notwithstanding developing countries’ increased resilience to such volatility, care should be taken to avoid a false sense of security. Past experience includes several cases where countries that were previously viewed as having a sustainable debt situation subsequently experienced an external debt crisis.
These cases, as well as experience with the HIPC Initiative, indicate that debt sustainability is a multifaceted concept that, like most other aspects of development, has to be considered in the light of the circumstances of each individual country. It is therefore encouraging that ways of introducing greater variability and flexibility into debt instruments, such as linking debt-service payments to capacity-to-pay (for example, through bonds indexed to GDP), are being examined. Equally welcome is the Paris Club’s more flexible approach to countries in debt difficulties. The lack of multilateral frameworks for resolution of debt crises continues to be one of the great vacuums in the international financial architecture.
Ensuring debt sustainability has been one of the difficulties challenging the HIPC Initiative because the measure of sustainability was based on unrealistic assumptions regarding economic growth, export growth and interest rates. The resulting need to provide additional relief in some cases demonstrates the need for a differentiated approach. More importantly, however, it highlights the low debt sustainability threshold in most low income countries and the consequent need for external resources to be provided on a grant rather than loan basis. Therefore, ensuring debt sustainability cannot be seen in isolation from the commitment in the Monterrey Consensus to provide additional concessional resources for development.Enhancing Voice and Participation of Developing Countries
The Monterrey Consensus stresses the need to broaden and strengthen the participation of developing countries and countries with economies in transition in international economic decision-making and norm-setting and it encourages the Bretton Woods institutions to continue to enhance the participation of these countries in their decision-making.